GOF - GOF: Watch For A Strategic Opportunity To Generate High-Yield Income

2023-05-22 14:50:31 ET

Summary

• Guggenheim Strategic Opportunities Fund consistently trades at a high premium while paying a 14% distribution that has never been cut.
• With a downward trending NAV, fund managers face a dilemma, as ROC accounts for nearly two thirds of the GOF closed-end fund distribution.
• There is likely to be an opportunity for new investors to buy if the premium is reduced over the next several months, depending on what happens with the broader market.

If you are seeking more than just alpha in your investment portfolio and are looking for a steady stream of income to turn into a river of cash later in your life, you may want to consider an investment in a fixed income fund from Guggenheim. The Guggenheim Strategic Opportunities Fund ( GOF ) is a taxable, fixed income and alternative asset closed-end fund ("CEF") that offers investors a steady distribution of $0.1821 every month. At the closing market price of $15.67 as of 5/19/23 that offers investors a yield of 13.95%. The fund NAV was $12.34 on that date, which means that the fund trades at a 26% premium to NAV, quite a bit higher than the 5-year average of about 16%.

For many investors who see the high yield distribution and read that the fund trades at a high premium, the first instinct is to avoid the fund altogether due to perceived high risk. It is difficult for most investors, even seasoned investors who have been watching the markets for decades, to comprehend how the fund can continue to pay out such a high yield distribution as the NAV continues to decline. But the fund managers, who were led by Scott Minerd until his sudden death in December 2022, have been managing the fund for 15 years and have never cut the distribution. In fact, they raised it several times after 2008 and have kept the same monthly distribution now for 10 years.

I realize that for many CEF investors, buying a fund that trades at a premium is generally not recommended, as the market price often fluctuates greatly and can move from a premium to a discount very quickly if market conditions change. However, in the case of GOF, the premium has actually continued to increase for most of the past 5 years with notable exceptions in December 2018 and March 2020, when it briefly traded near par. The premium to NAV is shown in the price premium/discount chart from CEFconnect , and it is clear that the trend is toward an ever-higher premium, although it may be due for a correction.

For those investors who only buy closed-end funds that trade at a discount, you may not get a chance any time soon with GOF. On the other hand, if you are patient and are interested in taking advantage of the strategic opportunities in the market that come around every now and then, you may wish to consider buying GOF if the premium drops back below 20% in the coming months. This may happen if the recession that many are expecting does in fact occur. Meanwhile, GOF announced the monthly distribution in line with previous for May payable May 31, so those who currently hold shares are swimming in cash.

While analysts have been warning of a distribution cut for a long time and claim that the fund cannot continue to pay out such a high yield distribution forever without reducing the NAV to zero, the fund managers continue to defy those predictions, at least for now. One of my favorite fellow analysts on SA, Nick Ackerman, whose opinion I completely respect, wrote an article in December 2022 that discussed the weak distribution coverage of the fund at that time and warned of danger ahead. Other analysts also offer caution, but all 5 of the most recent articles covering the fund indicate a Hold rating.

GOF Fund Basics

From the fund website , the investment objectives are described in detail:

The Fund’s investment objective is to maximize total return through a combination of current income and capital appreciation. The Fund will pursue a relative value-based investment philosophy, which utilizes quantitative and qualitative analysis to seek to identify securities or spreads between securities that deviate from their perceived fair value and/or historical norms. The Fund’s sub-adviser seeks to combine a credit managed fixed-income portfolio with access to a diversified pool of alternative investments and equity strategies. The Fund’s investment philosophy is predicated upon the belief that thorough research and independent thought are rewarded with performance that has the potential to outperform benchmark indexes with both lower volatility and lower correlation of returns as compared to such benchmark indexes. … The Fund may invest without limitation in fixed-income securities rated below investment grade (commonly referred to as "junk bonds"); the Fund may invest up to 20% of its total assets in non-U.S. dollar-denominated income securities of corporate and governmental issuers located outside the U.S., including up to 10% in emerging markets; the Fund may invest up to 50% of its total assets in common equity securities consisting of common stock; and the Fund may invest up to 30% of its total assets in investment funds that primarily hold (directly or indirectly) investments in which the Fund may invest directly.

The asset class breakdown includes 94% fixed income, with about 5% equity strategy, and 1% cash as of 3/31/23. The weighted average duration of the portfolio holdings is 4.2 years. The portfolio concentration is diversified with about 35% high yield corporate bonds, 30% bank loans, and 17% in asset backed securities as the largest holdings, with about 25% leverage as of 3/31/23.

The investment income that the fund generates is in large part based on corporate bond yields which have been generally rising since the beginning of 2022 as shown in this chart of the Moody’s Corporate Bond Yields for seasoned Baa (investment grade) bonds. That is good and bad news for fund managers because the reason why those yields are rising is due to increased fear of rising defaults, the declining health of the debt structure of some corporations, and general malaise in the overall health of the economy.

Credit spreads also began to widen starting in early 2022 and have been trending higher for the most part since then, exacerbated by the recent bank failures, which is another reason for concern and another factor to consider before investing in the fund. Depending on what happens with the debt ceiling negotiations and future interest rate hikes from the Fed, credit markets could get tighter, and defaults may continue to rise, affecting the loan default recovery rates and potentially leading to a loss of NII in future months.

The NAV of the fund has also been declining in 2023, from around $13 in January to $12.34 on May 19. Looking at a 3-year chart of the fund price vs NAV, it is evident that a disturbing trend appears with the decline in NAV while the fund continues to trade at a high premium.

The credit quality of the fund holdings is better than some other CEFs that offer high yield distributions based on fixed income investments, with about 35% of the holdings rated investment grade. The fund website shows a breakdown of the credit quality as of 3/31/23.

Distributions appear to consist of roughly 35% NII and 65% ROC for the past year or so. Unless the fund managers decide to sell more shares while the premium is high, or issue a rights offering to raise capital, there is a growing likelihood that the either the distribution will need to be trimmed, or some other action will have to occur to keep the NAV from declining further.

For 2022, the tax info was broken down for investors on the fund website and shows that about 43% was characterized as ROC for the full year. That may be an advantage for investors who hold GOF in a taxable account, but check with your CPA or a tax adviser to determine if that is a benefit to you based on your individual situation.

Summary and Recommendations

Like other analysts on Seeking Alpha, I believe that there are good things to like about Guggenheim Strategic Opportunities Fund, including the steady, high yield distribution that pays monthly dividends consistently regardless of broader market action. Conversely, there is some risk to the long-term value proposition if credit markets continue to deteriorate or if the economy spirals into a deep recession as many are still expecting. While there is continued uncertainty with respect to the health of the U.S. economy, especially while the debt ceiling issue remains unresolved, I would tend to avoid initiating a new position in GOF at the current premium level of 26%, unless you are willing to average down into a long-term income holding. There is likely to be a better opportunity to buy shares of GOF at a lower price in the near future, but then again, that has been the expectation for the past 6 months or more.

I am long Guggenheim Strategic Opportunities Fund in my No Guts No Glory income compounder portfolio and will look to add more shares if the price does drop. For others who are holding, I suggest continuing to hold. For new investors, caution is warranted regarding Guggenheim Strategic Opportunities Fund.

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